On 13 December 2018, California’s Air Resources Board (ARB) approved amendments for the state’s cap-and-trade regulation. The amendments specify changes required by last year’s AB-398 bill, which modifies and extends the program to 2030.

The amendments address cost containment, offsets, allocation, the phasing-out of exemptions, administrative issues, and the delinking with Ontario. For many aspects there were few changes from the draft changes released in September.

Price Ceiling: A reform of the cost containment mechanism was a central feature of AB-398. Between 2013 and 2020 California operates with the three-tiered Allowance Price Containment Reserve, which provides allowances at increasing levels of auction reserve prices. From 2021 onwards, the Californian Cap- and-Trade Program will operate with a hard price limit (ceiling) set at USD 65 per allowance. The Program will maintain its reserve price at auction, which effectively sets a lower price limit for allowances. In between the upper and lower price limits will be two “reserve triggers” (referred to as “speed bumps”) that, if reached, would result in additional allowances being auctioned (similar to the current tiered system). Those levels will be set at USD 41.40 and USD 53.20 in 2021. All reserve prices, including the price ceiling, increase by five percent annually and will be adjusted for inflation. However, the price ceiling opens the possibility that the emissions cap will be exceeded, as an unlimited amount of allowances are available at this price level. Therefore, for each allowance exceeding the cap however, Californian regulators are required to use price ceiling revenues to acquire offsets representing additional and verifiable emissions reductions elsewhere.

Direct Environmental Benefits: As per AB-398, half of the offsets used for compliance (four percent of overall compliance in 2021-2025, six percent thereafter) have to result in “direct environmental benefits” (DEBS) to the State of California. A performance standard will define whether specific offset activities result in DEBS. This does not automatically exclude offset projects implemented outside of California, which can be included when scientific evidence or project data provide evidence of DEBS.

Assessment of over-allocation: AB-398 mandated ARB to assess whether the state’s program is over-allocated and to consider the need for cap adjustments. ARB found no need for adjustments at this time, stating in its staff presentation that the allowance price was rising and there was no need to adjust cap trajectory as it was aligned with the statewide reduction targets set in AB-32 and SB-32.

Assistance Factors and Cap Decline Factors: Assistance factors are one component of the free allocation formula; they define the degree to which emitters receive free allocation based on their assumed carbon leakage risk. As per AB-398, all assistance factors will be set at 100% for all emitters receiving free allocation from 2018 onwards (partially implemented retroactively). According to calculations in the staff presentation, this will more than halve compliance costs for industrial entities in the 2018 - 2020 period – illustrating the significance of the change. In addition, cap decline factors – the rate at which free allocation is reduced to align with the cap trajectory – will be lowered for certain sectors deemed particularly at risk of carbon leakage.

Other aspects: The amendments also strengthen the mandate of the Executive Officer’s role to guarantee the environmental integrity of the program should a linked jurisdiction seek to revoke their own program. For example, the amendment provides provisions for withholding future allocation to account for any net surplus of imported allowances from a departing linking partner. The proposed amendments also include changes to methodologies for output-based allocation, as well as administrative changes.

The approved changes will take effect in April 2019. However, most changes will only enter into force in 2021 as they affect the post-2020 period.